I bonds are no longer the darling of investors now that the Federal Reserve has raised interest rates 10 times in a row to cool inflation. 

Interest rates on I bonds, which are set twice a year on May 1 and Nov. 1, are based on a fixed rate and a variable rate that moves with inflation. Last year, as inflation climbed to a 40-year high peaking at 9.1% in June, I bonds paid as much as 9.62%. Americans flocked to them because that return was much better than the losses endured by investors in the bond and stock markets last year and better than the relatively minuscule interest rate banks offered for deposits. 

Since then, inflation has eased below 5%, cutting May’s I bond rate to 4.3%, below the short-term benchmark Fed funds rate of 5% to 5.25% and the 5%-plus investors can get on riskless short-term Treasury bills, financial advisers said. 

“You can get better rates short-term now,” said Tom Balcom, advisor at 1650 Wealth Management. “Even most brokerages have a high yield money market fund that pays close to 5%.”  

Money market funds invest in short-term debt securities such as U.S. Treasury bills and commercial paper and pay investors income in the form of dividends. 

What is an I bond and how do they work?  

It’s a 30-year Treasury bond that protects you against inflation. It pays both a fixed interest rate and a rate that changes twice a year with inflation. 

Interest is compounded semiannually. That means every six months a new interest rate is applied to a new principal value that equals the prior principal plus the interest earned in the last six months. The bond’s value grows because it earns interest and because the principal value gets bigger.  

You can buy $10,000 worth from the Treasury and another $5,000 using your tax refund.

How big did the I bond market become last year? 

More than $32.3 billion I bonds were purchased from the Treasury last year, according to its data. That was up from about $5 billion in 2021.  

Nearly $6.8 billion in I bonds was bought in October alone, with demand so high that Treasury’s website crashed. 

Can I bond rates rise again? 

It’s possible I Bond rates will rise again if inflation resumes its climb, but it’s unlikely they’ll reach the peaks of 2022. Most economists and the Fed expect inflation to continue cooling. 

If inflation eases further, as expected, the 4.3% I bond rate could drop further when Treasury issues its next I bond rate in November. 

What happens if I keep holding my I bonds? 

You won’t ever lose money holding an I bond to maturity. The interest rate cannot drop below zero, and the redemption value of your I bond can’t decline. 

“If you don’t know if inflation has fully tapered off because there are still issues – like wages and gas are still high … you can continue holding them to see how it goes,” John Bergquist, managing member of Lift Financial, said. But he cautioned, “if it ends up the rate’s reassessed and drops 2 or 3 (percentage) points, then at that point, it may not be worth it.” 

What’s a better investment than I bonds right now? 

Unlike last year, many investments offer a better return than I bonds. Online savings accounts pay interest of between 4% and 5%; short-term Treasury bills offer over 5%, and the stock market, as measured by the benchmark S&P 500 index, has returned about 11% so far this year. 

Treasury bills paying the same or more than I bonds are particularly attractive. “They’re 100% liquid,” Bergquist said. “You could sell them any day, compared with having to hold them a year or more.”  

You can cash in I Bonds after 12 months, but if you do so in less than five years, you lose the last three months of interest. 

Advisers also suggest short-term bond floating rate exchange-traded funds, which invest in short-term bonds whose payouts increase as interest rates rise. Since the payout fluctuations account for rising rates, the floating rate bond prices remain pretty stable.

In contrast, fixed-rate bond prices generally fall to make their yield more in line with higher market interest rates. Prices and yields of fixed-rate bonds have an inverse relationship. 

But floating rate ETFs “can allow you to stay invested in the bond market, rewarding investors with higher income payments as the Fed hikes rates, rather than trying to time the market and waiting for the “right” time to invest in bonds,” wrote brokerage firm Charles Schwab in a report.

Note there’s a wide range of floating-rate ETFs. Some invest in corporate bonds, which can be riskier, but others invest mostly in safe Treasury bills.  

“For short-term cash, don’t take the risk,” said Balcom, who likes the WisdomTree Floating Rate Treasury Fund and JPMorgan Ultra-Short Income ETF.